Tahoe-Truckee Market Beat: Leveraged, inverse funds have grown in popularity
November 8, 2016
As I write this, the Presidential election is one day away and the stock market is soaring, having its best day in over six months.
The FBI announced that Clinton was not under investigation over the weekend, and global stock markets rallied on the news. Prior to Monday's rally, the stock market had been in one of its longest declines ever.
As of Friday, November 4th, the S&P 500 had dropped for nine straight days and that was it longest losing streak since 1980. The correction was not very deep, the market did not drop significantly, but nine down days in a row is a rare occurrence.
Markets don't like uncertainty and the prospect of a presidential candidate facing charges prior to an election was causing nervousness. Many investors like to hedge their portfolios during volatile times and today there are more tools available than ever before for hedging.
If you're thinking about hedging around events like elections and Federal Reserve meetings or other events that are on the calendar, be sure you understand the tools you have at your disposal and how they work.
Inverse and leveraged inverse funds have become very popular for hedging. They are highly liquid and can work well. A fund that is inverse the S&P 500 for example will go up when the market goes down and vice versa. A leveraged inverse fund is designed to go up two or even three times the amount that the market drops.
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What investors need to be aware of is that they are designed to move opposite the index on a daily basis and will not track well over longer time frames.
Over longer timeframes, they can lose value due to what is known as the "contango" effect. These funds are composed of short positions on futures contracts on the indexes and the value of the contracts is normally higher farther out in time.
This can result in some decay of the value of the fund as the contracts are rolled over.
So, if you want to do some hedging around election time, or the first year of the presidential cycle, which is normally the weakest year of the four-year presidential cycle for stocks, inverse funds can work well, but you need to know what timeframe you'll use them for and understand that they are not designed for holding long term.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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